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Disallowed Idemnity Deduction Blues

From time to time, corporate officers and shareholders agree to
indemnify their corporations for certain expenses and losses. The
taxpayer would prefer to claim an ordinary loss deduction instead of a
capital loss or, worse, a nondeductible payment. The Sixth Circuit Court
of Appeals recently denied such a claim.

Isaac Tigrett II was in the business of developing and promoting
restaurant and entertainment venues. After founding and building the
Hard Rock Café chain, he developed the House of Blues concept. As CEO
of HOB Entertainment Inc., Tigrett sought in 1996 to open a temporary
House of Blues at the Olympic Games in Atlanta. The corporate board
initially was not in favor, until Tigrett promised to indemnify the
corporation for up to $5 million of any losses. The House of Blues
opened but was shut down for 4 1/2 days after the bombing of
Centennial Olympic Park by Eric Rudolph. The corporation lost $10
million, and Tigrett paid the $5 million. The district and appellate
courts upheld the government’s position that the payment was designed
to generate a future benefit of an initial public offering of HOB
stock and denied it as an ordinary loss or expense.

The Sixth Circuit looked at the guarantee and payment as a single
transaction and regarded Tigrett’s concern for his business reputation
as a capital asset for which payments to preserve and protect were
nondeductible. Also, the payment was not “ordinary” within the meaning
of trade or business expenses in section 162, the court said. Tigrett
argued alternatively for a loss under section 165(c). This argument
also failed, since the U.S. Supreme Court has held that voluntary
payments of another’s loss are gratuities, not debts or losses [
Putnam v. Commissioner , 50 AFTR 502 (1956)]. They are either a
contribution to the capital of the corporation or a capitalized
payment to protect an individual’s business reputation, the court
said. It is extremely doubtful that any future taxpayer will be able
to obtain an ordinary loss for a similar indemnity agreement.